22208 Chap.8 Preparing the Statement of Cash Flows
Preparing the Statement of Cash Flows
Week 8 explains how cash moved during a period. The statement of cash flows groups inflows and outflows into operating, investing and financing activities and is built from a comparative balance sheet, the income statement and extra information.
Operating cash flow can be shown by the direct method, which converts each revenue and expense to cash, or the indirect method, which adjusts profit; both give the same total.
The lecture builds one complete statement from a comparative balance sheet and an income statement that includes depreciation, amortisation, a gain and a loss on disposals.
Operating cash flow is prepared by both methods and reaches the same figure, the sale of equipment appears under investing and a share buyback under financing, and the net change reconciles opening to closing cash. Practice questions add classification items and interpretation of a reconciliation.
What this chapter covers
- 01
What the statement of cash flows is for and how it is laid out
- 02
Operating, investing and financing categories
- 03
Direct method: converting revenue and expenses to cash
- 04
Indirect method: reconciling profit to cash
- 05
Investing flows from non-current assets
- 06
Financing flows from debt, shares and dividends
Worked example · free
Cash collected from customers
- 1Receivables rose by 44,500 − 36,000 = $8,500.
- 1A rise in receivables means less cash was collected than was sold.
- 1Cash collected: 410,000 − 8,500 = $401,500.
- 1It is reported as receipts from customers in operating activities under the direct method.
Key terms
- Operating activities
- Cash flows from day-to-day trading, including payments for inventory, wages, interest and tax.
- Investing activities
- Cash flows from buying and selling non-current assets and investments.
- Financing activities
- Cash flows from borrowing and repaying long-term debt, issuing or buying back shares and paying dividends.
- Indirect method
- A presentation of operating cash flow that starts from profit and adjusts for non-cash items and working capital changes.
- Direct method
- A presentation of operating cash flow that lists cash receipts and payments by type.
- Net cash flow
- Cash inflows minus cash outflows for a period, explaining the change in the cash balance.
Preparing the Statement of Cash Flows FAQ
Why is a gain on sale subtracted under the indirect method?
The full sale proceeds are reported under investing activities. The gain is already inside profit, so leaving it there would count part of the same cash twice; subtracting it removes the duplicate, and a loss is added back for the same reason.
Where does interest paid go?
In this subject interest paid is an operating cash flow, because it is part of a business’s daily operations, even though the loan that causes it is a financing item.
Is higher operating cash than profit always good news?
Not necessarily. Read the adjustments: if operating cash is high only because payables rose sharply, the business may simply be paying suppliers later, while rising receivables and stock can signal slower collection and weak sales.
How do the direct and indirect methods differ?
The direct method lists actual cash receipts and payments by type, such as receipts from customers and payments to suppliers. The indirect method starts from profit and adjusts it for non-cash items, disposal gains and losses, and working capital changes. Both give the same operating total.
Why does the source of cash matter?
Cash from operations shows the business generating money from its own trading, which can continue. Cash from financing, such as new loans, must be repaid or rewarded, so a business relying on it is more fragile. The topic stresses that poor cash management is a main reason small businesses fail.
Exam move
Start every question by listing the change in each balance sheet account and labelling it operating, investing or financing. Prepare operating cash flow both ways on the same data until the totals match, then finish by proving the net change against opening and closing cash.
In written parts, comment on where cash came from as well as how much there is; the topic stresses that cash from operations is a healthier source than new borrowing. Close each practice question by reading your finished statement as a manager would: which category supplied the cash, which consumed it, and whether operating cash covers investment without new borrowing, because written parts often ask exactly that.
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